August 30, 2023

Insights and analysis for the professional investor

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Welcome to Crypto Long & Short!

This week, Diana Barrero Zalles and Dan Garzia explain how a vital DeFi figure is evolving as tokenized real-world assets become a thing.

Then, Jason Hall and John McNiff talk about the benefits of indexes to crypto.

As always, get the latest crypto news and data from CoinDeskMarkets.com.

– Nick Baker

From the Analyst

A Guide to TradFi Blockchain Adoption

As decentralized finance, or DeFi, continues to evolve and mature, the concept of total value locked – a measure of how much money users have stashed in a given protocol – has also gained significant attention. Originally focused on digital assets such as cryptocurrencies, TVL has expanded to include tokenized real-world assets (RWA), providing a more comprehensive understanding of the assets represented on-chain. These tokenized assets are typically held in smart contracts on a blockchain network.

Since RWA, such as mortgages, private equity investments and illiquid funds, have not been historically represented on-chain, TVL primarily focused on the value of digital assets deposited within DeFi protocols. However, as blockchain technology adoption by traditional financial institutions progresses, the inclusion of RWA, measured within the TVL framework, becomes increasingly relevant and necessary. This is a natural progression in line with the continued development of the DeFi ecosystem, which is coming to embrace tokenized RWAs as part of TVL. Moreover, as DeFi platforms attract institutions and large-scale investors (which are vital for scaling), it becomes increasingly attractive to offer the ability to trade tokenized bonds, equity, debt and other assets such as gold, real estate and art.

While integrating RWAs into the TVL metric is still in its early stages, with only about $300 billion locked on-chain, the current state of the blockchain layer-1 and layer-2 landscape shows the following figures representing TVL as of July 2023.

Source: Arcana Analytics

Most blockchains' TVL is largely representative of digital assets, such as cryptocurrency and NFTs, although there are a select few notable blockchains whose TVLs are heavily weighted to RWAs. A great example is Provenance Blockchain, which has an overall TVL of $9.3 billion, of which more than $8.1 billion is from real-world financial assets, such as home equity line of credit (HELOC) loans, private equity and alternative asset funds. RWAs are gradually making their way onto the blockchain, further expanding the TVL metric and its significance.

Importance of TVL to TradFi

As financial and insurance services lean into blockchain-based solutions through tokenized RWA, the RWA TVL metric becomes an important indicator of what blockchain to tokenize assets on. Multiple factors are involved in selecting a blockchain to tokenize RWAs on, such as which blockchain has the most robust tooling for easy onboarding and lifecycle management of financial assets, an ability to achieve compliance and privacy standards and a function to achieve security and scalability requirements.

Perhaps the leading indicators of the above are:

Where the majority of tokenized financial assets exist today.
Where the momentum of RWA tokenization is occurring.

By identifying a blockchain's current RWA TVL and TVL growth over time, an institution can assess these questions and ultimately select the most appropriate blockchain platform to support transactions in tokenized RWAs. The blockchains with the greatest gravitas, as indicated by real-world financial asset TVL, are probabilistically also best positioned as a long-term sustainable solution for institutions seeking greater transparency, efficiency and productivity.

As with any new data set, the challenge to date has been that RWA TVL data is not readily available and rarely segmented by asset class, meaning it is difficult to assess what portion of a given TVL value consists of cryptocurrency assets versus real-world assets. As is the case with Provenance Blockchain, some blockchains are aiming to self-publish their TVL data by asset class. Additionally, several analytics firms are also working to make this data more accessible, such as RWA.xyz, which focuses on data for tokenized real-world assets. RWA TVL is a necessary data point and standard for financial services and insurance institutions deciding which blockchain to leverage.

TVL is a crucial indicator for institutions seeking to tokenize RWAs, helping them identify the most suitable blockchain platforms based on real-world asset adoption and growth. As the financial industry continues to adopt these innovations, RWA TVL is expected to play an instrumental role in guiding decisions and driving institutional adoption.

This article is adapted from the Global Blockchain Business Council's report on "Real-World Assets Total Value Locked (TVL): From DeFi to TradFi." To read the complete report, click here.

— Diana Barrero Zalles and Dan Garzia

A message from Messari

Come build with us and register for Mainnet 2023, the premiere crypto event of the year!

Hosted by Messari, Mainnet returns to Pier 36 NYC from Sept 20-22. Mainnet unites together the leading voices in crypto and will spotlight the true innovations propelling crypto forward, with programming focusing on regulation & policy, real-world finance & DeFi, operators & builders, AI's native currency, and a wide variety of other topics. This year, Mainnet will feature 100+ in-person speakers from across the crypto and TradFi landscapes, including Coinbase's Brian Armstrong, Circle's Jeremy Allaire, Ripple's Brad Garlinghouse, Stellar's Denelle Dixon, EY's Paul Brody, PayPal's Jose Fernandez da Ponte, Onyx by J.P. Morgan's Tyrone Lobban, and many more.

Institutional Outlook

Why Good Indexes Are Vital to Crypto's Future

Indexes are pivotal in asset markets as the cornerstone of financial market growth and an essential tool for investors. In crypto, however, the nascent state of index availability and adoption is a significant impediment for investors. Currently, the equivalent advice to "buy the index" is to purchase bitcoin (BTC) or Ethereum's ether (ETH) in a centralized account, which is insufficient to attract new capital from sophisticated investors. Indexes allow for efficient asset allocation, risk management, product development and performance measurement. Without indexes, crypto cannot evolve into an institutional financial market.

Many of the required components for a successful index exist today: compliant institutional exchanges, robust data and sophisticated methodologists, among others. However, what is missing in the U.S. is regulatory support and index adoption that captures the more nuanced and differentiating aspects of crypto markets, such as proof-of-stake reward rates. Despite the absence of regulatory guidance, the industry must continue to push forward with the development of indexes.

We summarize the impact of index adoption in the following six sections:

Price discovery and credibility: Indexes facilitate price discovery by aggregating data from multiple sources and calculating a representative value. Investors struggle to determine fair values without reliable indexes, hindering market participation. Professionally managed indexes instill credibility, bolstering confidence in retail and institutional investors.

Benchmarking and investment products: Indexes provide benchmarks against which asset performance can be measured. Investors struggle to reliably compare different investment products or managers without established indexes. This lack of benchmarking impedes the creation of investment vehicles like derivatives (a key component to sophisticated portfolio management) and cryptocurrency ETFs (which could attract significant retail and institutional capital).

Risk management and transparency: Indexes help investors assess the risk and volatility associated with an asset. The absence of reliable risk metrics hampers investors' ability to manage their exposure and transfer risk effectively. Even more than their predecessors, Web3 indexes are fully transparent as all data is viewable on-chain. Fully transparent indexes enhance risk assessment by improving asset allocation models and contributing to market stability and a more informed investment process.

Market research and analysis: Indexes offer valuable data for academics and analysts to study market trends, correlations and behaviors. This research informs strategies and contributes to a deeper understanding of the asset class, ultimately aiding its development.

Standardization and language: Indexes promote standardization in measuring and evaluating market performance. A lack of established indexes in the crypto market hinders the creation of a common language and universal standard among market participants. Without indexes to establish reference rates, markets cannot reach the depth needed to attract significant capital.

Institutional participation: Professionally managed indexes attract institutional participation by providing a reliable foundation for investment decisions. Institutional involvement enhances market liquidity and stability, accelerating overall asset class growth.

Indexing is vital for the advancement of new asset classes like crypto. While currently hampered by the regulatory environment in the U.S., efficient and professionally managed indexes would improve the safety and stability of markets. As the cryptocurrency industry continues to evolve, the development and adoption of reputable indexes is instrumental in attracting institutional investors, increasing liquidity and advancing the overall maturity of the asset class.

– Jason Hall and John McNiff, Methodic Capital

Takeaways

From CoinDesk Deputy Editor-in-Chief Nick Baker, here is some news worth reading:

ETF TIME?: Grayscale (disclaimer: It, like CoinDesk, is owned by Digital Currency Group) has for years had the biggest U.S. exchange-traded security that owns bitcoin (BTC). The Grayscale Bitcoin Trust (GBTC) is not an ETF – a vehicle that would, undoubtedly, be the more attractive product for investors. Grayscale has been trying to convert it into one, but the U.S. Securities and Exchange Commission has said "no." Grayscale sued and a federal appeals court just ruled the SEC's rejection was problematic. This kicks the case back to the SEC for review, and while the regulator could still object to the conversion, the judges severely criticized the SEC's previous rationale.
CRYPTO TAXES: The U.S. government just gave more clarity on how it wants to tax crypto, guidance many have for years yearned for. It, of course, didn't satisfy everyone and the boos started quickly. Many of the complaints centered around key DeFi players like Metamask and Uniswap, who allegedly don't have the resources or structure needed to keep up with recordkeeping demands. Crypto miners are presumably happy, though, since the potentially onerous taxation scheme that's been talked about didn't appear in the U.S. proposal.
Boring BTC: It's been an incredibly sleepy August for bitcoin. There was the sudden plunge on Aug. 17, but it's been mostly quiet otherwise. But then the decision in the Grayscale case brought life back to the market, pushing BTC back above $28,000. There's been much talk about how it's going to be hard for bitcoin to rally in the near future, but the creation of bitcoin ETFs – if that comes to pass – is the kind of catalyst capable of boosting prices in a big way.

Want more? For the latest news affecting the crypto markets, listen to CoinDesk's Markets Daily podcast.

State of Crypto: Policy & Regulation

It is now more important than ever to set industry standards and align on practical short-term and long-term objectives through pointed conversations with the best legal minds and Washington D.C.'s most important decision makers.

Join us at State of Crypto: Policy and Regulation on October 24 in Washington D.C. for an unprecedented opportunity to evaluate, dissect and ultimately shape crypto regulatory frameworks that support a vibrant, secure and healthy future for the digital economy.